Q4 results: Maruti Suzuki’s margins hit cost bump but growth stays on track

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Maruti Suzuki India Ltd’s growth is expected to accelerate in the next few years, backed by new launches.

The country’s largest carmaker, which manufacturers one in every two cars sold, did well in the March quarter. It overcame odds such as higher costs, rising competition and foreign exchange fluctuations, on the strength of a robust 15% year-on-year increase in sales.

The company’s management told analysts in an earnings call that it is confident of sustaining the current pace of volume growth. In fiscal year 2017 (FY17), Maruti Suzuki sold 10% more vehicles than it did in the previous year, a little better than the industry growth. Analysts think it can do better, with a Kotak Institutional Equities Research report forecasting a 12% compound annual growth rate between FY17 and FY20.

The 10% volume growth was when the company’s factories were at full capacity, which led to waiting periods for some of its new launches. The Gujarat plant has started production and now capacity constraints are behind it.

Maruti Suzuki’s volume growth is not merely a question of numbers. A higher share of premium vehicles in the sales mix gives hope for an expansion in earnings. A 4.6% year-on-year expansion in average realization during the March quarter reinforces this point. Further, new launches would also reduce the discounts offered. Note that the average discount per vehicle at Rs15,194 was substantially lower than the year-ago period and the December quarter too. To some extent, the slew of new vehicles launched during the year partially mitigated the discounts offered.

The company’s net sales rose by a robust 19% year-on-year to Rs18,333 crore in the March quarter, in line with the Street’s average estimates. However, operating profitability took a toll as raw material costs increased as a percentage of sales. It posted close to a 130 basis points dip in operating margin. Some analysts say that profitability took a beating, partly because of the new Gujarat plant. Till it ramps up, the trend of low-margin growth may continue.

Stiff competition will continue to be a challenge, which is likely to entail higher marketing and advertising costs. Existing firms continue to be aggressive, while new ones such as Kia Motors are entering the market too. This may cap the upside in margins.

That said, the higher revenue will trickle down to growth in operating profit. The March quarter’s operating profit grew by 10% and despite lower other income, net profit rose by 15.8% higher over a year ago to Rs1,709 crore.

The improving profile of the company’s performance has kept investor confidence high. Not surprisingly then, the stock at Rs6,371 trades at about 23 times its estimated FY18 earnings, a premium to its five-year average of 19 times. Such high valuations may explain why the share did not react to its results. These valuations indicate belief that Maruti Suzuki can sustain strong sales growth and translate it into equally strong earnings growth in the next few years. Any slippage on that front could see the share suffer.